INTRODUCTION TO MICROECONOMICS

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Dr. David A. Dilts Department of Economics, School of Business and Management Sciences Indiana - Purdue University - Fort Wayne $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$ May 10, 1995 First Revision July 14, 1995 Second Revision May 5, 1996 Third Revision August 16, 1996 Fourth Revision May 15, 2003 Fifth Revision March 31, 2004 Sixth Revision July 7, 2004 $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Introduction to Microeconomics, E201 8 Dr. David A. Dilts All rights reserved. No portion of this book may be reproduced, transmitted, or stored, by any process or technique, without the express written consent of Dr. David A. Dilts 1992, 1993, 1994, 1995 ,1996, 2003 and 2004 Published by Indiana - Purdue University - Fort Wayne for use in classes offered by the Department of Economics, School of Business and Management Sciences at I.P.F.W. by permission of Dr. David A. Dilts
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II. Reading Assignments
III. Appendix A Sample Midterm Examination ........................................................................................... 222 Sample Final Examination................................................................................................. 229 IV. Appendix B Bibliography, book list ...................................................................................................... 236
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PREFACE
This Course Guide was developed in part because of the high cost of college textbooks, and in part, to help organize students= studying by providing lecture notes. This Guide was made possible because the administration of IPFW had the foresight to make the campus= printing services available to duplicate these sorts of materials, and provide them at cost through the auspices of the University Bookstore in Kettler Hall. Without the active participation of both the campus duplicating services, and its most cooperative staff, and the bookstore this would not be available.
The department, school nor the professor make anything whatsoever from this Guide. In fact, the department=s budget and the professor=s own resources are used in the writing of the Guide, and the numerous draft copies that are produced in the revisions of this document. Like the sign in the Mom and Pop bait shop on Big Barbee Lake says, “This is a non-profit organization, wasn’t planned to be B it just sorta worked out that way.” Well, actually it was planned to be a non-profit enterprise in this particular case.
The professor also wishes to acknowledge the fact that several students have proposed changes, improvements, caught errors, and helped to make this document more useful as a learning tool. Naturally, any errors of omission or commission are those of the professor alone.
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Introduction & Use of Guide
This Course Guide is provided to assist students in mastering the subject matter presented E201, Introduction to Microeconomics. The commercially available student guides and workbooks are notoriously inadequate and are simply of little value. At several institutions, prepared course materials are made available to students to assist their learning. What research has been done concerning these course specific materials, suggests that students' performances are enhanced by having access to these types of materials. Because microeconomics is such an important foundation for business, engineering, and the social sciences this Guide has been prepared.
The purpose of this Course Guide is fourfold. First, the course syllabus is included in the Guide. Second, the Guide provides the student a listing of the key concepts covered in the lectures. Third, the Guide provides students with problems and study-guides to aid each individual in the retaining the materials presented by the text and lecture. Fourth, sample exams are offered as self-test exercises and to give students an idea of the level of mastery expected in this course. Organization
The Guide is divided into eleven units, following the organization of the Tentative Course Outline found in the syllabus. At the end of each chapters in the reading assignments there is a section containing the key concepts developed in the chapter, sample exam questions and a brief study guide. Also in the Guide is the course syllabus included before the eleven sections covering the substantive portions of the course. Following the reading assignments are the lecture notes for each chapter. The final section of the Guide contains sample examinations, including answers. Note to Students
There is no substitute for doing the reading assignments, attending class, and working through the material. A teacher cannot cause a student to learn, all a teacher can do is to organize and present the material, grades can provide a small extrinsic reward for accomplishment, but it is the student's ability, effort, and desire that determine how much and how well they will learn. It is hoped this Guide will help in the learning effort.
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SYLLABUS E201, Introduction to Microeconomics Dr. David A. Dilts Department of Economics and Finance Room 340D Neff Hall School of Business and Management Sciences Phone 481-6486 Indiana - Purdue University - Fort Wayne COURSE POLICIES
1. In all respects, the policies of the School, Department, IPFW and the University shall be applied in this course.
2. Office hours will be posted on the professor's door, appointments may also be
arranged. The Professor's office is Neff 340D.
3. The following grade scale will be applied in this course for determination of final grades:
A 100 - 90 percent B 89 - 80 percent C 79 - 70 percent D 69 - 60 percent F below 60 percent
All final grade calculations shall be rounded up. In other words, 69.01 and 69.99 percent are both considered 70 percent and will earn the student a grade of C.
4. The majority of undergraduate economics courses this professor has taught have
had average final grades that fall within the range centered on 2.0 on a 4.0 scale.
5. Course requirements:
The mid-term examination is worth 40% of the final grade, the final examination is worth 50% of the final grade, and there will be at least three quizzes, the best two scores on these quizzes will be worth 10% of the final grade.
A. Examinations will consist of objective items. Examinations will be
worth 100 points, and will consist of twenty multiple-choice questions (worth four points each), and twenty true-false questions (worth one point each).
B. Quizzes are worth twenty points each, and will consist of
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three multiple choice questions (four points each) and four true false questions (worth two points each)
C. If there is a 10-point improvement on the final exam over
what was earned on the midterm, then the weights will be change to the midterm being worth only 30 percent and the final exam being worth 60 percent of the final grade.
6. The final examination will be given at the time and place scheduled by the
university. No exception is possible.
7. No make-up exams will be permitted. If you cannot attend class at exam time, you must make prior arrangements to take an equivalent examination before your classmates. Exceptions may be granted for cases where there was no possibility for an earlier examination, i.e., injuries or illnesses, etc B things clearly beyond the student=s control.
8. Academic dishonesty in any form will result in a course grade of F and
other sanctions as may be authorized by the university. The over whelming preponderance of students do not engage in dishonesty, and the professor owes it to these students to strictly police this policy.
9. The provisions of these policies and the course objectives are subject to
testing. These policies are also subject to change at the discretion of the professor and do not constitute a binding contract.
COURSE OBJECTIVES
This is an introductory principles of economics course that covers topics in microeconomics. The breath of topical coverage limits the course objectives to subject matter mastery. The course will present factual material concerning the operation of the firm and household as well as the development of rudimentary understanding of economic decision-making. REQUIRED TEXT David A. Dilts, Introduction to Microeconomics, E201. Fort Wayne: 2004, memo. SUPPLEMENTAL TEXT
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Campbell R. McConnell and Stanley L. Bruce, Economics, twelfth edition. New York: McGraw-Hill. [M&B in the outline] TENTATIVE COURSE OUTLINE
1. Introduction to Course and Economics
Dilts, Chapter 1 M & B Chapter 1
2. Economic Problems
3. Circular Flow
5. Supply and Demand: Elasticities
Dilts, Chapter 5 M & B Chapter 20
6. Consumer Behavior
MIDTERM EXAMINATION
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9. Monopoly
10. Introduction to Resource Markets
Dilts, Chapter 10 M & B Chapter 27
11. Wage Determination
12. Epilogue
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Lecture Notes
1. Economics Defined - Economics is the study of the ALLOCATION of SCARCE resources to meet UNLIMITED human wants.
a. Microeconomics - is concerned with decision-making by individual economic agents such as firms and consumers. (Subject matter of this course)
b. Macroeconomics - is concerned with the aggregate performance of the entire economic system. (Subject matter of the following course)
c. Empirical economics - relies upon facts to present a description of economic activity.
d. Economic theory - relies upon principles to analyze behavior of economic agents.
e. Inductive logic - creates principles from observation.
f. Deductive logic - hypothesis is formulated and tested.
2. Usefulness of economics - economics provides an objective mode of analysis, with rigorous models that are predictive of human behavior.
a. Scientific approach
b. Rational choice
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3. Assumptions in Economics - economic models of human behavior are built upon
assumptions; or simplifications that permit rigorous analysis of real world events, without irrelevant complications.
a. model building - models are abstractions from reality - the best model is the one that best describes reality and is the simplest B Occam=s Razor.
b. simplifications:
1. ceteris paribus - means all other things equal.
2. There are problems with abstractions, based on assumptions. Too often, the models built are inconsistent with observed reality - therefore they are faulty and require modification. When a model is so complex that it cannot be easily communicated or its implications easily understood - it is less useful.
4. Goals and their Relations -
a. POSITIVE economics is concerned with what is;
b. NORMATIVE economics is concerned with what should be.
1. Economic goals are value statements, hence normative.
c. Economics is not value free, there are judgments made concerning what is important:
1. Individual utility maximization versus social betterment
2. Efficiency versus fairness
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d. Most societies have one or more of the following goals, depending on
historical context, public opinion, and socially accepted values :
1. Economic efficiency,
2. Economic growth,
3. Economic freedom,
4. Economic security,
6. Full employment,
a. interpretation - precise meanings and measurements will often become the subject of different points of view, often caused by politics.
b. goals that are complementary are consistent and can often be accomplished together.
c. conflicting - where one goal precludes, or is inconsistent with another.
d. priorities - rank ordering from most important to least important; again involving value judgments.
6. The Formulation of Public and Private Policy - Policy is the creation of guidelines, regulations or law designed to affect the accomplishment of specific economic goals.
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a. Steps in formulating policy:
1. stating goals - must be measurable with specific stated objectives to be accomplished.
2. options - identify the various actions that will accomplish the stated goals & select one, and
3. evaluation - gathers and analyzes evidence to determine whether policy was effective in accomplishing goal, if not re-examine options and select option most likely to be effective.
7. Objective Thinking:
a. bias - most people bring many misconceptions and biases to economics.
1. Because of political beliefs and other value system components rational, objective thinking concerning various issues requires the shedding of these preconceptions and biases.
b. fallacy of composition - is simply the mistaken belief that what is true for the individual, must be true for the group.
c. cause and effect - post hoc, ergo propter hoc - Aafter this, because of this@ B fallacy.
1. correlation - statistical association of two or more variables.
2. causation - where one variable actually causes another.
a. Granger causality states that the thing that causes another must occur first, that the explainer must add to the correlation, and must be sensible.
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d. cost-benefit or economic perspective - marginal decision-making - if
benefits of an action will reap more benefits than costs it is rational to do that thing.
1. Focus on the addition to benefit, and the addition to cost as the basis
for decision-making.
a. Sunk costs have nothing to do with rational decision-making.
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Lecture Notes
1. The economizing problem involves the allocation of resources among competing wants. There is an economizing problem because there are:
d. unlimited wants
e. limited resources
2. Resources and factor payments:
d. land - includes space (i.e., location), natural resources, and what is commonly thought of as land.
1. land is paid rent
e. capital - are the physical assets used in production - i.e., plant and equipment.
2. capital is paid interest
f. labor - is the skills, abilities, knowledge (called human capital) and the effort exerted by people in production.
3. labor is paid wages
d. entrepreneurial talent - (risk taker) the economic agent who creates the enterprise.
4. entrepreneurial talent is paid profits
3. Full employment includes the natural rate of unemployment and down time for normal maintenance (both capital & labor). However, full production or 100% capacity utilization cannot be maintained for a prolonged period without labor and capital breaking-down:
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a. underemployment - utilization of a resource in a manner, which is less
than what is consistent with full employment - using an M.D. as a practical nurse.
4. Economic Efficiency consists of the following three components:
a. allocative efficiency - is measured using a concept known as Pareto Superiority (or Optimality)
1. Pareto Optimal - is that allocation where no person could be made better off without inflicting harm on another.
2. Pareto Superior - is that allocation where the benefit received by one person is more than the harm inflicted on another. [cost - benefit approach]
b. technical efficiency - for a given level of output, you minimize cost or (alternatively) for a given level of cost you maximize output.
c. full employment - for a system to be economically efficient then full employment is also required.
5. Allocations of resources imply that decisions must be made, which in turn involves choice. Every choice is costly; there is always the lost alternative -- the opportunity cost:
a. opportunity cost - the next best alternative that must be foregone as a result of a particular decision.
6. The production possibilities curve is a simple model that can be used to show choices:
a. assumptions necessary to represent production possibilities in a simple production possibilities curve model:
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3. fixed technology
4. two products
7. Law of Increasing Opportunity Costs is illustrated in the above production
possibilities curve. Notice - as we obtain more pizza (shift to the right along the pizza axis) we have to give up large amounts of beer (downward shift along beer axis).
8. Inefficiency, unemployment and underemployment are illustrated by a point inside the production possibilities curve, as shown above. (identified by this symbol):
a. Inefficiency is a violation of the assumptions behind the model, but do not change the potential output of the system.
9. Economic Growth can also be illustrated with a production possibilities curve. The dashed line in the above model shows a shift to the right of the of the curve which is called economic growth.
Beer
Pizza
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a. The only way this can happen is for there to be more resources or better technology.
b. Growth will change the potential output of the economy, hence the shift of
the entire curve.
10. Economic Systems rarely exist in a pure form. The following classification of systems is based on the dominant characteristics of those systems:
a. pure capitalism - private ownership of productive capacity, very limited
government, and motivated by self-interest.
1. laissez faire - government hands-off; markets relied-upon to perform allocations.
2. costs of freedom - poverty, inequity and several social ills are associated with the lack of protection afforded by government.
b. command - government makes the decisions - with force of law (and sometimes martial force)
1. Often associated with dictatorships
c. traditional - based on social mores or ethics or other non-market, non-
legislative bases
d. socialism - maximizes individual welfare based on perceived needs, not contributions; generally concerned more with perceived equity than efficiency.
e. communism - everyone shares equally in the output of society (according to their needs), generally no private holdings of productive resources
1. The former Soviet Union espoused communism, but also was mostly
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command
2. Utopian movement in the U.S.
f. mixed system - contains elements of more than one system - U.S. economy is a mixed system (capitalism, command, and socialism are the major elements, with some communism and tradition)
1. All of the high income, industrialized economies are mixed economies
e. Even with mixed systems there are substantial variations in the amounts of socialism, capitalism, tradition, and command exist in each example.
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Lecture Notes
1. The modern economic system is no longer the closed (i.e., U.S. only) system upon which the debates surrounding isolationalism occurred prior to World War II.
a. Imports and Exports are increasingly important
b. Foreign investment versus U.S. investment abroad
1. Outsourcing
1. Current accounts (import v. exports)
2. Capital accounts (foreign investment)
2. Capitalist Ideology - The characteristics of a capitalist economy and the ideology that has developed concerning this paradigm are not necessarily the same thing. The elements of a capitalist ideology are:
a. freedom of enterprise
e. a very limited role for government
f. different countries with different views of these matters B i.e., equity v. efficiency again.
3. Market System Characteristics - the following characteristics are typical of a system that relies substantially on markets for allocation of resources. These characteristics are:
a. division of labor & specialization
b. capital goods
c. comparative advantage - is concerned with cost advantages.
1. Comparative advantage is the motivation for trade among nations and persons.
2. Terms of trade are those upon which the parties may agree and depends on the respective cost advantages and bargaining power.
4. Trade among nations
a. the reliance upon comparative advantage to motivate trade B assuming barter:
Belgium Holland
Tulips 400 4000
Wine 4000 400
The data above show what each country could produce if all of their resources were put into each commodity. For example, if Holland put all
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their resources in tulip production they could produce 4000 tons of tulips but no wine. Assuming the data give the rate at which the commodities can be substituted, if both countries equally divided their resources between the two commodities, Belgium can produce 200 tons of tulips and 2000 barrels of wine and Holland can produce 200 barrels of wine and 2000 tons of tulips (for a total of 2200 units of each commodity produced by the two countries by splitting their resources among the two commodities). If Belgium produced nothing but wine it would produce 4000, and if Holland produced nothing but tulips it would produce 4000 tons). If the countries traded on terms where one barrel of wine was worth one ton of tulips then both countries would have 2000 units of each commodity and obviously benefit from specialization and trade.
b. absolute advantage for one trading partner results in no advantage to trade.
1. LDCs often have no comparative advantage and hence the developed countries, possessing absolute advantage have no incentive to trade (.
2. LDCB Less Developed Country - Low-income countries B 60 B (per capita GDP of $800), middle-income countries B 75 B (per capital GDP of $8000).
3. High income countries and developed countries (19 countries) 4. High income countries without economic development (Hong Kong,
Israel, Kuwait, Singapore, and UAE)…